The US small-cap cap market has experienced its fair share of volatility over the last few years. Although we are still facing many of the same challenges as last year, alongside some fresh ones, US equities have already priced in a lot of pain and valuations relative to large-caps are at historic lows.
Although we are still facing many of the same challenges as last year, US equities have already priced in a lot of pain and valuations relative to large-caps are at historic lows.
One of the most compelling aspects of small-caps are relative valuations compared to their large-cap counterparts. Given the extended run of underperformance vs large-caps – the Russell 2000 Index has underperformed the S&P 500 Index in eight of the past 12 years – we believe that valuations are very attractive and could be a precursor to the start of a small-cap cycle.
Performance coming out of these periods is quite compelling for small-caps. In the 10 years following the tech bubble, small outperformed large eight out of 10 times and by over 400 basis points per year on average, when comparing the Russell 2000 vs its large-cap counterpart – the Russell 1000.
US small-caps in particular allow investors an opportunity to gain US exposure, with around 80% of revenues coming from the domestic market. The S&P 500 gets approximately one third of its earnings from overseas compared to the Russell 2000’s 20%, so US small-caps are more of a domestic play.
For the JP Morgan US Smaller Companies Trust, we’re looking to find, innovative companies in the small-cap sphere that serve market niches, with higher earnings growth and higher potential returns. Many of these small but quality companies are less researched. The average small-cap name has five or six analysts – for large-caps this could be double.
An example of one of these innovative companies is WillScot Mobile Mini, a provider of portable accommodation and secure storage containers. The company hosts a national network of 16 site locations across the US with more than 40,000 units and has around 17,000 customers.
As an industry leader in flexible workspace and portable storage solutions, this small-cap company is well positioned to stand the test of time in a period when people are adapting to flexible working.
Another way investors can tap into the positive prospects for small-caps is through healthcare companies, we like HealthEquity, which provides technology that helps consumers and employers manage Health Savings Accounts (HSAs) and other consumer-directed benefits.
The company reported strong quarterly earnings in December due to good organic HSA member growth. The company also provided guidance of strong growth in 2023 including margin expansion.
Compelling investment ideas across the small-cap market have universal attributes, they showcase quality, good management and consistency of earnings even in times of inflationary pressure.
Yet, at the end of 2022, approximately 40% of companies in the Russell 2000 Index were unprofitable. In order to navigate this under researched market, it’s important to seek active management in this realm.
Jon Brachle is manager of the JPMorgan US Smaller Companies Investment Trust. The views expressed above should not be taken as investment advice.